Syndication Law & The Private Placement Memorandum Attorney Understanding Waterfalls in Real Estate Syndication
The topic discussed revolves around the distribution of returns, known as 'waterfalls,' in real estate syndication. The speaker used an example to explain the distribution process: a $5 million property bought entirely with investor funds that yields annual rents of $550,000.
In this scenario, the investors are promised a 7% preferred return, also known as a 'pref,' amounting to $350,000 annually. This pref gets distributed first from the rental income. Any income beyond this pref, in this case, $200,000 ($550,000 - $350,000), is then split between the investor and the sponsor in a 70:30 ratio. This means the investor receives an additional $140,000, and the sponsor gets $60,000.
Upon selling the property for $6.5 million in year five, the first payout is the return of the principal investment of $5 million to the investors. Since the 7% pref has been regularly paid, the next step is dividing the remaining $1.5 million between the investor and the sponsor, again in a 70:30 ratio. This results in $1,050,000 for the investor and $450,000 for the sponsor.
To calculate the internal rate of return (IRR), a T-bar diagram is used, which tallies all payouts across the investment period. The total annualized return for the investor in this example is 13%.
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